Variance and beta as perceived risk: questionable science

Abstract

PurposeThe purpose of this paper is to discuss the origin of variance and beta as risk measures and to identify their shortcomings as perceived risk metrics.Design/methodology/approachThe paper analyses seminal literature from economics, psychology, and neuroscience that have relevance to financial risk.FindingsThere is empirical evidence that investors are loss‐averse and affectively influenced. Variance and beta as conventionally calculated are flawed because they do not take into account the inherent indeterminacy of the investor's world.Practical implicationsThe paper demonstrates that perceived risk will be systematically mis‐measured and that risk premium/return anomalies will prevail until a more affective and multidimensional risk metric is utilized.Originality/valueThe value of the paper lies in its concise and clear identification of financial risk measurement issues and a suggested direction for remediation.